February 9, 2018 /9:55 AM /Fitch Ratings
Abenomics has supported the reflation of Japan's economy in the five years since it was launched, but is yet to have a significant impact on wage growth which has remained stagnant even as the labour market has tightened. A sustained improvement in nominal GDP growth could help ease the government's difficult fiscal consolidation challenge, but growth momentum is likely to falter in the absence of healthy wage gains, says Fitch Ratings in a Special Report from its economics team.
Abenomics consists of "three arrows" - loose monetary policy, flexible fiscal policy and structural reforms - that form a policy package intended to reflate the economy. Nominal GDP has risen by almost 10% since the policies were introduced in early 2013, reversing a decline that had extended from the end of the 1990s. Consumer price inflation has remained well below the Bank of Japan's (BOJ) 2% target and inflation expectations are still very low, but measures of domestically generated inflation have at least stabilised or increased, after falling for two decades.
The turnaround in large part reflects the success of ultra-loose monetary policy in pushing real interest rates into negative territory. Private-sector lending has picked up, suggesting loose policy has gained traction. Growth in lending to businesses has been particularly strong, and has underpinned a rise in investment growth.
The sharp fall in the yen in the early stages of Abenomics may also have helped net export volumes by spurring competitiveness and propping up business profits. However, the currency depreciation also squeezed real wages and consumption, and our analysis shows it had no clear effect on broad economic activity.
One of the most striking achievements under Abenomics has been the strong growth in employment, bolstered by a sharp rise in the participation rate as a higher share of the female population has joined the labour force. This supply-side improvement has more than cushioned the impact of a declining working-age population.
Fitch does not expect the BOJ to tighten policy by raising rates or changing its yield target in the next two years. Nevertheless, demographic headwinds could halt the momentum that Abenomics has created behind nominal GDP. We expect the labour force and employment to start shrinking within the next few years without new incentives to attract further potential entrants. There is even a risk that Japan will slip back into deflation once employment starts to decline, unless there is a lasting improvement in wage growth.
Wage stagnation has been the main disappointment of Abenomics, and there is no guarantee that labour market tightness will eventually translate into strong wage increases. There are structural characteristics in Japan's labour market that tend to supress wage pressures - such as an industrial relations system that emphasises employment stability over pay increases. Low inflation expectations have also tempered wage demands. The lack of progress on the "third arrow" of structural reform, which was intended to address Japan's relatively low labour productivity, has been another drag on wage growth.
The share of national income going to an increasingly profitable corporate sector has risen amid weak wage growth, while the share going to labour has fallen since the end of the 1990s. This may have dampened the recovery in aggregate demand, given the corporate sector's high savings rate.
Reforms to boost workers' bargaining power make real wage determination more sensitive to labour market slack and productivity, and lift productivity growth could all potentially help address wage stagnation, and are likely to be key to prolonging the positive effects of Abenomics.
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